Nick Lee, Head of Regulatory Affairs at OakNorth
In 2008, a number of the largest, most ‘systemic’ UK banks were in financial distress and the UK Government was forced to use taxpayer funds to ‘bail them out’. The Government was forced to do this as failure of one or more of these large institutions would have had severe implications for financial stability in the UK. These banks were so large and important to the economy that they were seen as ‘too big to fail’. Solving ‘too big to fail’ has been one of the most important regulatory issues of the past decade and rightly so.
As well as increasing system wide capital and liquidity requirements, to reduce the likelihood of taxpayers having to foot the bill in the future, a ‘resolution regime’ was created by the Bank of England and other authorities across the world. In theory, this new regime should mean that if a systemically important bank were to fail in future, the resulting disruption to the economy would be limited and a future taxpayer funded bailout should be unnecessary. As a result of this new regime large banks had to raise debt equal to their capital requirement, so that in a crisis, should they burn through their equity (for example, because they made significant losses due to bad debts) they could effectively ‘reload’ their equity base by converting the debt they had raised to equity, this taking them back to being fully capitalised. This is known in the UK and Europe as the ‘MREL regime’.
The Bank of England’s Prudential Regulation Authority has been lauded rightly for its policy innovation to reduce “barriers to entry to UK banking”. This has succeeded in creating 25 new banks (such as OakNorth Bank, Paragon, Aldermore, Metro Bank, Starling Bank and Monzo), delivering inward investment, creating additional lending capacity which means more jobs and homes, delivering innovation and enhancing consumer choice in a market dominated by a number of big institutions. However, the ability for these new banks and existing mid-tier and specialist firms to scale, grow and deliver genuine competition with incumbent, high-street banks is being hampered by barriers to growth, particularly the MREL regime.
In the UK, one of the main MREL triggers is activated when a bank’s assets pass the £15bn level. Although on paper this seems significant, in other comparative jurisdictions this level is set much higher (approx. £180bn in the US and £85bn in the Euro zone), to cover only ‘systemic’ banks. MREL is designed to prevent the costs of failure of these large, systemic banks falling on the taxpayer, which very few would argue against. However, smaller and mid-tier banks are classified as ‘non-systemic’ e.g. their failure would have little or no impact on financial stability and the taxpayer would not be asked to recapitalise them. Eligible deposits would be covered by the Financial Services Compensation Scheme (FSCS) and the failed bank’s role in providing credit to the economy would quickly be replaced by their competitors. Any shortfall in FSCS resources would be met by a sector wide levy on all banks, not by tax payers.
However, the cost of MREL issuance for smaller ‘non-systemic’ banks is generally prohibitive. There are few providers of such debt and the costs of issuance are usually 3 to 4 times the cost that large systemic banks face, making the MREL issuance market for these size of banks almost dysfunctional. Therefore, the current resolution regime threshold of £15bn discourages growth, with mid-tier and specialist banks being in essence being forced to remain below a certain size to avoid being “captured” by the regime and raising MREL. This leaves a notable absence of mid-tier competitors of scale that can support SMEs, help create jobs and homes, provide choice, innovation and competition, drive regional growth and investment and help level-up the country. More competition and the wider availability of credit to the economy actually enhances financial stability.
A strong mid-tier and specialist banking sector is a critical component to the future growth and prosperity of the UK economy, especially as we forge a new path outside the EU and seek to rebuild the economy post-pandemic. Throughout the last 15 months of COVID-19, these banks have played a vital role in supporting customers and businesses as they face the greatest economic shock in a generation. The smaller scale of these banks means they’re more closely embedded in the communities they serve, providing a more focused service to people and businesses and are able to react quickly when their clients require support
To ensure the MREL regime captures only the largest ‘systemic’ banks, the Bank of England could increase the MREL trigger to £50bn of assets, rather than the current £15bn. By doing so, mid-tier ‘non systemic’ banks could unlock between £24bn to £28bn in additional lending capacity over the next five years. With an estimated multiplier effect of 3 to 4 times to the real economy, this change could be fundamental to the future growth prospects of the UK economy, without significant impact on financial stability. Moving the trigger to £50bn would also bring us more in-line with our partners in Europe and the US.
MREL is one area where change is needed to remove barriers to growth for scaling banks, there are others. Good regulation should be risk based and proportionate and take account of the systemic impact of the bank. Requirements and expectations should increase as banks grow, but through r a gradual “hill” of increasing regulation, rather than a series of “plateaus” and “cliff faces”, which can hinder growth and competition. With a huge amount of good work having gone into enabling new banks to enter the market, it’s vital that the necessary steps are taken to ensure an appropriate and proportionate regulatory environment is created for them to scale.
 This is based on debt interest savings from current and potential MREL debt issuance by mid-tier banks and building societies over the next 5 years being used to support a mix of retail and SME lending.